Blog

Paying off debt 101: The fool proof method!!

Last week we posted an article that showed you how to create a budget (even if you had never done one) and the reasons why a budget is the best jump start to be financially free. We also gave you some free resources to do it quickly. This week’s post is equally important, being part of a financial trio that we at Saving For Hope believe are key for people to get out of the cycle of poverty.

It is estimated that young families in the US will have more debt this year than in any other point in history. According to usatoday.com the whooping average debt for a US household is $279,469.00 (which includes 4 categories: 1- Mortgage: $182,421.00, 2-Student Loans: $50,626.00, 3- Auto Loans: $29,539.00, and 4- Credit cards: $16,883.00) Maybe your debt is not that high! But if you still have some and you want to get it out of your life for good, keep reading and let’s get to work.

Paying off debt 101:

In this post, we will tell you how to start paying off debt. However, before you start doing so, at this point you should have a budget in place and you should know exactly: 1-how much money is coming in (earned),2- how much is going out, and 3- all the places that the money you earned goes to. If you do not have this action plan in place, we suggest that you start there. Click here to start a budget.

Know how much you owe. At this point you should have all your financial categories in check. Look at all the debt you have and write it down from the smallest amount up. Do not include your mortgage at this stage, because we want to get rid of debt that cost you more. If you have a mortgage, we will address how to get rid of it later. It is important to say that there is an enormous difference between a credit card debt and a student loan debt, for example. We don’t have to go over all the details to explain why they are different, due to space, but the point is that you should concentrate on the debt that takes the most money out of your family’s budget, and that is your credit card debt.

Action plan:

1- Organize your debt from the smallest to the largest. To be effective paying it off, you first need to know how much you owe and to who.

2- Add all the minimum payments of each one to a single total. When you have that number, make sure you budget covers it. if your budget does not cover the minimum payments, you need to increase your income (step #1 of our Budget 101 post)

Two philosophies. There is an old debate about paying off credit card debt. On the one side, you have people that say, you should pay the ones with the highest interest rates first (regardless of amounts) to save some money (it is true, the highest the interest the more your payout). Getting rid of those CC first makes financial sense. On the other side, there is people that argue that high interest is not the way to go, but smaller amounts should be paid first.

Let’s see how those 2 philosophies look on a simple example: Let’s say you have 2 credit cards. CC #1 has a balance of $300.00 at 10% interest, and CC #2 has a balance of $1,000.00 at 18% interest. People on the first side of the argument will tell you: pay CC #2 because the interest rate is higher. People on the second side of the debate will tell you pay CC #1 because it has a lower amount. We at Saving For Hope believe, that the second approach is the best way to pay debt off, for several reasons. We will write an article about that later, but, we are not alone. See Dave Ramsey’s examples with a few cool examples here. Dave calls this method the snowball method.

Action plan:

1- Pay the minimum payment on all your debts, except on the smallest one.

2- whatever money you got left over on your budget will go to the smallest debt to pay it off quick. After the smallest one is paid, the minimum payment that was freed up, will go to the next one.

Repeat, repeat, repeat: This is not rocket science!! Seriously, just repeat the process adobe. Target the next smallest amount of debt and continue to pay minimum payments on the rest. Use the extra money on your budget and get the second one paid off. Continue to do so until all your pesky credit card debt is gone for good.

Action plan:

1- As you pay your smallest debt off, continue to add that minimum payment to your next smallest amount.

2- Save money during these few months doing slight changes to keep it up. This is the most critical part of the plan: stay with it.

Move on, to other debt. After all your credit cards are out of the way, start to work on your larger debt, like car loans, boat loans, student loans, and finally your mortgage (this should be your last). People at this stage are in much better financial place than most families in the US. When you get here you will feel great and you will have improved your family’s chances to have a better future.

Action plan:

1- Pay your smaller amounts, and then move to larger amounts until you are debt free but your mortgage.

2- Only after all other debt is gone, start paying extra payments on your mortgage. This will help you save a ton of money on interest and it will put your family on a great financial position.

There you have it, in a few months you will be able to get rid of a TON of DEBT that it is costing you thousands of dollars and you can start using that money to build a brighter financial future.

Our next article will teach you how to start saving like a mad person, stay tuned. Enjoy!